Prediction: We will soon see bitcoin-denominated VC funds

The bitcoin ecosystem saw its first big exit today when popular blockchain gambling site SatoshiDice sold for approximately $11.47 million to an unnamed acquirer. Perhaps appropriately, the transaction was paid in bitcoin, with seller Erik Voorhees receiving 126,315 bitcoins in exchange for his 15-month old company.

As when sellers accept stock as part of a transaction, the value of bitcoin can fluctuate dramatically between the time they’re received and liquidated. Instagram may be the most famous example of this, in light of Facebook’s lackluster IPO, but any company acquired by Yahoo over the last 10 years would be equally apropos. So it’s a risk, but at least the cryptocurrency is relatively liquid and has real-time price transparency. And the recipient isn’t locked into holding bitcoins – presumably he could sell any time. This isn’t the case when a seller receives stock, which often comes with limits as to when shares can be unloaded.

But it raises the question of whether bitcoin could find its way into unrelated financial transactions. Several companies have begun using bitcoin to pay salaries and countless online and brick-and-mortar merchants accept it for payment.

How far are we from the day that a venture capitalist offers to invest 10,000 bitcoins into a fledgling company at a 70,000 bitcoin pre-money valuation? And would it be responsible or even savvy for an entrepreneur to accept?

The value of a single bitcoin has fluctuated madly throughout 2013, rising from a low of approximately $20 to a brief high of $266 on April 10, before losing $160 in value over a 10-hour span and ultimately closing the day at $130. Compared to these enormous swings early in the year, the currency has been relatively stable over the last three months or so, bobbing between $80 and $130. As I write this it’s $92.70.

Despite this normalization, the fluctuations in bitcoin value would seem to be too large still for cashflow- and runway-conscious founders to accept. A founder could obviously liquidate his bitcoins immediately after receiving them, but this would generally defeat the purpose. He could also achieve some arbitrage by choosing the best available exchange rate, which might not be in US dollars. For any company operating in multiple countries, bitcoin’s cross-border flexibility is a plus, but this is unlikely to be attractive enough to justify the risk and hassle.

But, if the above-described price variance narrows in the future as the volume of bitcoin trading and utilization increases, I can see a time when it could be sufficiently attractive to accept bitcoin-based investment. Entrepreneurs, by their nature, are aggressive and comfortable taking risk. For a founder who believes that bitcoin will increase in value over time, accepting a VC investment denominated in the virtual currency might be rather enticing. And doing so may even give the entrepreneur negotiating leverage over his investors in terms of valuation and deal terms.

There are other challenges beyond price fluctuations that a company would face when operating entirely, or even largely in bitcoin. The broader financial infrastructure needed to support you average business has yet to catch on to virtual currency trend. For example, payroll, credit cards, lines of financing, and all manner of other service types would need to exist for a company accepting a bitcoin investment to continue holding its funds digitally. At the same time, the average business must pay dozens of employees and vendors, each of which would need to be willing to accept the virtual currency – again, until infrastructure exists to seamlessly convert virtual to fiat currency for these transactions.

A bitcoin-denominated VC fund wouldn’t be the first financial vehicle based on the virtual currency. Romania’s MPEx is a bitcoin securities exchange, and the Winklevoss twins, well-known bitcoin investors, recently filed with the SEC to form a bitcoin exchange traded fund (ETF). VCs have also demonstrated their comfort holding shares in companies that depend on bitcoin, with companies including BitPay, CoinBase, and others raising millions of dollars (in green money).

A bitcoin-based VC fund remains an idea well outside the box. But it is also exactly the kind of idea the enterprising financial engineers and adrenaline-fueled entrepreneurs gravitate toward. For that reason alone, I suspect it won’t be long until someone gives this idea a shot. Whether it proves to be a good decision remains to be seen and will in many ways be subject to factors beyond the control of these investors and the entrepreneurs they back. Either way, it will be an exciting experiment to track.